A Taxing Development

State tax law changes rewrite the rules

by Natalie Burg

From the October, 2011 issue

Ask developers what their business is really about, and they'll give you an assortment of answers. For some it's simply a revenue game; for others it's about historic preservation or community building or job creation or simply the magic of making something out of nothing.

But before any of those motives come into play, all developers will say that their industry is first and foremost a numbers game. That is, for any property to be developed or redeveloped, many figures must be plugged into many equations, and the end result must at least promise to show a net gain.

Since the 1990s, those equations have included a pair of Michigan tax credits: 5 percent of the cost of historic renovations, and 12.5 percent for redeveloping "brownfields." Those credits can make or break the feasibility of a project.

"It's a philosophy that the state has embraced," says Brett Lenart of the Washtenaw County Department of Economic Development & Energy, who administers the area's Brownfield Redevelopment Program, "that redeveloping these [blighted] sites is a challenge and the public should support them."

Today it would be more accurate to say that this "was" a philosophy that the state of Michigan "did" embrace. In May, the GOP-controlled state legislature voted to cut business taxes by $1.8 billion. They made up most of the lost revenue by taxing senior citizens' pensions--but $400 million came from eliminating existing business incentive programs, including the brownfield and historic preservation credits.

So what does that mean for the future of development in Ann Arbor? While it's difficult to say how future redevelopment projects will be affected, it's very easy to see the impact the programs have had in the past.

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Jon Carlson estimates that he and his partners at 2Mission Design and Development, Chet Czaplicka and Greg Lobdell, have invested $14 million redeveloping historic properties in Ann Arbor using the state tax credits. Their projects include the restoration of the buildings housing Grizzly Peak, Cafe Zola, Cafe Habana and Blue Tractor

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on Washington and Vinology on Main. Carlson describes historic renovation as a delicate mix of passion and finance.

"Architecture is like free art," he says of the partners' decision to focus on the preservation of historic properties. "When you walk in a downtown that has beautiful buildings, it's like being in a gallery. We found a passion for it because of that, and also we thought we could get a good return for those reasons."

Restoring a historic building in compliance with local and federal standards, however, is no walk in the park.

"You have to be ready for the headaches," Carlson says, "but you also need to care about the architecture and the fabric of a downtown. It's much easier to be in a suburb and building a white box out of bad materials--and it's much cheaper.

"I think the credit works great," he says, "but [we'll take] whatever can make these projects viable."

Nancy Finegood, executive director of the Michigan Historic Preservation Network, cites job growth, historic tourism, and downtown development as benefits of historic preservation. But she especially emphasizes her belief that restoring historic properties is good environmental policy.

"A historic building is the greenest building of all," says Finegood. "You're not putting anything into landfills. Those buildings have stood for 100, sometimes 200 years. New buildings aren't quite the same quality."

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While tens of millions have been spent on historic projects locally, that pales next to the hundreds of millions that have gone into brownfield developments: Washtenaw County's Lenart says that in the twelve years brownfield incentives have been available, they've helped stimulate $323 million of investment.

Brownfield tax credits and tax-increment financing encouraged developers to reuse environmentally damaged or economically obsolete sites instead of healthy "greenfields." Some local projects used credits, some used tax increment financing that reimburses redevelopment costs out of future property taxes, and many utilized both.

"I look at it if you are building a development you have a choice," says Lenart. "You know if you're going to develop a brownfield site [instead of a greenfield site], you are going to have the costs to remove contamination. These incentives bridge that gap."

But like the historic preservation credits, the brownfield incentives are on the way out. Though nothing is yet set in stone at the state level, according to Nancy Finegood, instead of credits being awarded separately to qualifying brownfield and historic preservation projects, cash grants will be awarded in both categories--but from the same, much smaller, pot.

"The administration is talking about an appropriation for a grant or a loan structure," says Finegood. The most recent news from Lansing is that next year's budget will include $100 million for historic preservation, brownfields, and any other redevelopment projects that apply for assistance--with no plans to appropriate any funding for the following year.

"That's a pittance compared to what's needed," Finegood says. She says that the state awarded approximately $170 million to brownfield projects last year, and another $15 million in historic preservation credits. Not only does the new plan change how the incentives would be paid out and cut the amount nearly in half, but it also requires historic and brownfield projects to compete against each other for the same funds.

It's unclear what criteria will be used to judge one type of project against another. Previously, the credits were awarded almost automatically, so long as a property met the relevant criteria. If a historic preservation project met federal and local standards, a 5 percent state tax credit was awarded--in addition to an available 20 percent federal tax credit.

Though 5 percent sounds small compared to the 20 percent federal credit, it's no trifle when it comes to million-dollar investments. In fact, the 5 percent from the state was sometimes more meaningful than the 20 percent offered by the federal government for historic preservation projects.

"The difference is that even though the state credit is smaller," says Carlson, "it's much easier to use, so it's more effective." Because the federal credit can be applied only to certain expenses, it's hard to collect the full amount. In fact, Carlson estimates that the 5 percent from the state often had a bigger impact on most projects than did the 20 percent federal credit. In his experience, the two together covered about 10 percent of his total project costs.

Some may. "You'll see ... urban and rural areas with projects that won't get done," predicts Carlson. "I think Ann Arbor won't be affected as much in terms of historic property rehabbing not occurring [at all], but you're not going to see people using the right, expensive materials. They'll get done, but they just won't look as good."

In renovating the Grizzly Peak building, Carlson says, "we couldn't have used the original red sandstone from a quarry in the UP" without the tax credits. "We could still have remodeled it, we just couldn't have used those special materials that were a part of the building's original design."

Carlson notes that it is smaller developers like him, those who work on projects costing $5 million or less, who are most likely to have to make sacrifices in the quality of their work. Large, out-of-state developers who work on large-scale projects are likely to be unaffected. "Because a lot of Ann Arbor buildings are small buildings, larger developers won't come in and do those small jobs," Carlson says. "We'll have to make some compromises."

Though brownfields have attracted outside developers, those projects haven't always gone well. None of the three approved brownfield projects listed on the city's website--William Street Station, 200 South Ashley, and Broadway Village at Lowertown--has been built. The Broadway Village site, on Maiden Lane, remains a vacant lot--despite $96 million in promised brownfield funding and a $20 million equity investment from the state pension fund.

As with historic preservation, homegrown brownfield projects have been more successful. The highly visible Zingerman's Deli expansion is currently using the credits to offset $1.2 million of a $6.7 million budget. A TIF credit--which won't be affected by the state changes--is kicking in another $800,000.

According to managing partner Grace Singleton, the cost of upgrading infrastructure while putting a major addition on the historic deli meant the brownfield credits were integral to their planning process. "Without the credits we wouldn't be building the same project," says Singleton, "and it's possible that we would have taken an entirely different approach to our expansion."

Singleton says that she doesn't know what "the project would look like if the tax credits were not available," but adds, "I'm thankful we didn't have to sort that out. [It] would have impacted our projected revenues and employment forecasts."

That's because under the new law, when developers look at the numbers, they'll be looking at a new set of equations. Instead of criteria which, if met, would offset some of the extra costs of historic or brownfield projects, they'll be entering a competition--one that may or may not pay off.

Not all developers see that as a problem. Ed Shaffran has developed a variety of projects in Ann Arbor, including historic preservation--which he did before the state credit was available. And while he's worked with other developers on projects that have utilized brownfield credits, he has not used them on any of his own properties.

"My feeling is that if you're basing your deal on the kind of economics where the tax credits are necessary to make it a reality, it's not a very good deal," Shaffran says. "Your deal needs to make sense on income and expenses.

"Certainly, you would love to see them retained," he says of the credits, "but I'm not going to be crying any big tears about" their elimination.

Even Carlson isn't feeling pessimistic. But then, he's not just a developer: he's also a partner in businesses that employ 950 people across the state. They will benefit from the same changes that curtailed the historic and brownfield credits.

"I understand those cuts directly affect something I do for a living," Carlson says, "but I think that this vision, while painful, is needed to get the state back on track." Thanks to the tax law changes, he says, his group is developing a new business that will employ about eighty people.

With so many interconnected factors at work, it's too early to predict just how the tax changes will change Ann Arbor. The one certainty is that whatever state and local governments do, the most important decisions will be made in the undramatic quiet of developers' offices, as they work on their new equations.